Disciplinarians’ Dilemma

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In a 2000 interview with CFO, business guru Gary Hamel claimed that finance executives are the enemy of innovation. And that was when times were good. Today nearly all CFOs have a mandate to conserve cash, and that intensifies the pressure to put a cap on corporate creativity. Indeed, a new McKinsey study finds 40% of companies surveyed are actively seeking to reduce research-and-development costs and reducing the number of R&D projects they are funding.

Yet slashing R&D budgets for the near term will place companies in precarious competitive positions when the economy does turn around. The challenge for CFOs is to figure out how to fund the innovation that will drive future growth while ensuring that the company actually makes it to the future. Those who can strike this balance will not only help their companies but also themselves: far from being regarded as numbers people with myopic vision, they will earn reputations as strategic thinkers focused on growth.

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Instead of acting as the enemies of innovation, CFOs can play a critical role in fostering the development of new products, ideas, and processes. And they can do it while staying true to their natures: by applying the finance department’s hallmark fiscal hawkishness to innovative initiatives. A recent study by Boston Consulting Group, in fact, finds that some companies’ biggest weaknesses in innovation center on the very processes where CFOs can add value — things like sticking to a timeline, earmarking funds, and balancing a portfolio of innovations. (See “Room for Improvement” at the end of this article.)

“People think that discipline and innovation are foes,” says Scott Anthony, president of Innosight, the strategy consulting firm founded by Clayton Christensen, author of The Innovator’s Dilemma. “But in fact they’re very good friends. By using discipline, helping people take the right risks, and applying what they know about managing portfolios, CFOs can be huge enablers of innovation.”

Jack Jenkins-Stark, finance chief at BrightSource Energy, a developer of large-scale solar-energy projects, recalls that at a former employer, a software company, the management team would meet to consider as many as 120 new projects competing for funding in a given year. “Almost inevitably, the first question asked was, ‘How much can we spend?'” says Jenkins-Stark. “One of the most important things the CFO can do is set that bar.” Once his fellow executives understood the rationale for the budget range he was suggesting, “the dialogues about what to fund and what not to fund were much more focused,” he says.

Instead of trying to weigh in on which is the most deserving or worthwhile technology to pursue, a role he cedes to the company’s technical experts, Jenkins-Stark brings his knowledge of the business’s financial resources to help shape the conversation. “I can provide an overall guideline around corporate demands for capital and indicate an acceptable range of spending,” he says. “I can provide information about how much each initiative will cost, and I can ask really hard questions about time-to-market or time-to-economic-results.” Such data helps the full management team make faster, more-informed decisions, he says.

At a prerevenue company such as BrightSource, resources are clearly finite. But even at large, cash-rich companies, “one of the CFO’s jobs is to help people realize that there are constraints on both time and money,” says Jenkins-Stark.

Such limitations can actually improve companies’ ability to develop breakthrough ideas, says Anthony. “One reason why large companies have historically struggled to innovate is that they often have too much time, too much money, and too much patience. They can follow a fatally flawed strategy for too long,” he says.

The finance chief’s analytical approach to innovation can keep companies from making the classic mistake of throwing good money after bad, says Rajesh Chandy, a professor of marketing at the University of Minnesota’s Carlson School of Management who recently completed a study of innovative practices at 759 firms around the world. “One advantage to being quantitatively focused is that you can look at things in a dispassionate manner,” he says. Since the finance chief is unlikely to be personally involved with the development of new products, he can look at the economics of continued investment in a struggling project from a reasoned distance and might have an easier time deciding to halt any further spending than would members of the business unit or project team.

By applying a portfolio management approach to innovation, the CFO can also help a company strike the right balance of long-term, higher-risk efforts versus less-adventurous projects with a higher probability of a near-term payoff. “Just like an individual portfolio has stocks and bonds, some of which are riskier than others, a corporate innovation portfolio needs some balance as well,” says Anthony.

One possibly damaging consequence of many companies’ recent shift to lower-risk innovations — like making modifications to an existing product rather than launching a whole new product category — is that it may leave them without the “next big thing” that could kick-start significant growth as the economy recovers. Safer bets, while helpful in the short-term, are not typically game-changers. (See “Managing an Innovation Portfolio” at the end of this article.)

A New Point of ViewThere can be a learning curve for finance chiefs who want to become innovation advocates. “You need to spend time learning about the market environment and the political and regulatory environment, so that you can better understand what is driving the marketing team and the tech team,” says Jenkins-Stark. “My comments in a management meeting are more likely to make the right impact when people realize that I’ve taken the time to understand the issues they’re dealing with.”

Developing that credibility as a CFO “comes from years of working together,” says Jim Frates, finance chief at Alkermes, a biotech firm. Frates regularly has informal lunches with Alkermes’s scientists. “It helps me get a better sense of their challenges and it helps them get a better sense of how their project fits into a portfolio of things we’re working on across the company,” he says.

An understanding of their companies’ innovation goals and efforts can also help finance executives find creative solutions to funding challenges. “Sometimes you run the numbers and it may not make sense to do the full-blown initiative, but it does make sense to do a piece of it. Maybe you undertake a smaller effort or something geographically specific,” Jenkins-Stark says. These smaller-scale projects may be able to sustain the research or idea until more funds become available. They can also serve as valuable test runs for a technology or product.

Although Alkermes has been able to maintain its research budget despite the recession, Frates says many biotech firms have shelved second- and third-priority research streams recently and are focusing all their resources on the projects that are most likely to reach their next development milestone. “As the CFO, you say, ‘I don’t really want to cut this. How can we approach this in a different way? What’s the most critical thing we can do so that we can keep moving and hit the next milestone?'” he says.

Finance chiefs may also need to adjust their thinking about what a project’s outcome, budget, and timeline should be. “Many finance folks understandably prefer quantification,” says the University of Minnesota’s Chandy. “But the impact of products that will help you in the future cannot be easily quantified. The whole point of innovation is that sometimes it’s unpredictable.” In Chandy’s study, innovative companies tended to have greater tolerance for this unpredictability.

“If you really are going into a new market space or doing something that’s never been done before, you really can’t have numbers in which you have any degree of confidence,” agrees Anthony. “It does require that CFOs look beyond the numbers in a spreadsheet.”

Jenkins-Stark says sometimes he has to do just that. While he creates models to test different possible outcomes for new efforts and strives to come as close as he can to a real price tag and timeline, he is willing to consider projects that don’t add up on paper. “Ask yourself whether an initiative might be worth it if it might open up avenues that you don’t anticipate and can’t quantify,” he says.

Ultimately, a healthy dose of the CFO’s trademark pragmatism can also help companies protect their innovation goals without exceeding their resources. Jenkins-Stark recalls one session at a former employer in which the management team was unable to winnow the list of worthy projects down to the budgeted amount for the year. “I said, ‘Let’s just do them all,'” he says. “I knew there was no way the organization had the time and resources to do all the projects we were talking about.” His gamble paid off: the company completed only about half the projects that were approved and came in under budget, without Jenkins-Stark’s needing to veto anything.

By showing respect for the company’s innovation efforts and sharing his perspective on the business’s resource needs and limitations, the CFO can shed his stereotypical role as the enemy of innovation and instead become an invaluable guide in the company’s quest for growth. Says Jenkins-Stark: “The CFO needs to help shape the discussion, rather than stifle it.”

Kate O’Sullivan is a senior writer at CFO.

Managing an Innovation Portfolio

How do CFOs decide when to make a big bet?

Just as they strive to find the right balance of risk and return in day-to-day operations, CFOs must also bring their knowledge of portfolio strategy to their companies’ innovation efforts. Innovative projects span a spectrum of risk, with updates and new features for existing products and services on one end (some reward, low risk) and groundbreaking new inventions on the other (high reward potential, high risk). In the past year, according to a recent McKinsey study, more companies have focused on the former. But Mike Smiley, finance chief at Zebra Technologies, a maker of bar-code, RFID, and other identification technologies, says CFOs need to help their businesses think long-term, too — and not just to keep the R&D department happy. “Investors don’t want to hear only about short-term profitability,” he says. “They want to hear about long-term growth.”

The challenge is that long-range projects are hard to value. Instead of trying to find data that may not exist to build a traditional discounted cash-flow model for such a project, “sometimes you need to go out and create data to find out if something’s worth doing,” says Scott Anthony, president of Innosight, a consulting firm that focuses on innovation. “This is where the instinct of the CFO, the need to have a little bit of proof, is a good one.”

Finance chiefs can get at least some of that proof by taking gradual steps to test their theories. “Instead of thinking it’s going to cost $100,000 to launch this project and we can’t afford it, think about spending $10,000 on market research or $50,000 to test part of the technology,” Anthony says.

He cites Procter & Gamble as a company that frequently tests small batches of new products before investing in a complete rollout. Amid the recession, other companies are following suit. “People are trying to figure out smart, creative ways to test ideas without running through gobs of money,” says Anthony. Online surveys, small-batch tests, and computer simulations are all tools companies can use to test promising concepts.

Looking for patterns and trends, rather than analyzing a single project in isolation, can also help finance executives vet big ideas, says Anthony. Management teams can try to identify the factors that have driven growth in their industry and company in the past, and look for those characteristics in the ideas they’re considering. For example, Jim Frates, finance chief at biotech company Alkermes, says the company’s long-term focus is on so-called non-substitutable drugs. “Me-too products, where there’s just a tweak to make them slightly better, will not be good enough,” he says. — K.O’S.